News Tone, Investor Sentiment, and Liquidity Premium
41 Pages Posted: 24 May 2021 Last revised: 19 Aug 2022
Date Written: August 17, 2021
Investor sentiment affects stock market liquidity by affecting noise trading and irrational market makers. Previous studies have focused on this effect with the time-series variation in sentiment and liquidity. This paper utilizes firm-specific news sentiment (FSNS) to examine its effect on stock liquidity in China stock market and show that firms with an optimistic tone cause a rise in trading activity while decreasing price impact and transaction cost. We also find that pessimistic stocks exhibit a stronger predictive effect on stock returns than optimistic stocks. After decomposing liquidity into non-sentiment-driven components, we find that the liquidity premium is declining but remains significant. This declining pattern indicates that FSNS contributes to explaining the liquidity premium. We also show that monetary policy uncertainty, growth of margin trading, and institutional ownership are the underlying mechanisms driving the predictability of stock liquidity.
Keywords: investor sentiment, liquidity, liquidity premium
JEL Classification: G12, G14, G32
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